Generally speaking, commodities are an alternative investment class to other financial assets, such as bonds and stocks. Investing in commodities, in addition to other financial assets, has provided investors an opportunity to diversify their portfolios. Investing in commodities may provide long run returns like investing in bonds and stocks, but commodity prices are generally not correlated with prices of bonds and stocks.
One approach for investing in commodities has been through indices that rely only on front month contracts. A front month contract is a futures contract that represents an agreement to buy or sell a particular commodity at a predetermined price at a date of maturity in the future. A front month contract is repeatedly bought at the same distance on a forward curve. For example, as illustrated in FIG. 1, the distance out on a forward part 101 of the curve is the time at which a futures contract is bought 101b before it matures 101a. Time to maturity is the time (measured in days or months) until a futures contract is due. The time until a futures contract matures at the time it is bought is also called the tenor of a futures contract.
A second approach for investing in commodities has been to use baskets of futures that provide exposure further out on the forward curves. A basket of futures is a commodity index composed of different futures contracts.
Experience with these investment strategies has demonstrated some common drawbacks. First, these investment strategies have led to problems in an environment with unusually steep contango curves responsible for large negative roll yields (see, for example, FIG. 2). In such an environment, the value of the commodity varies significantly in terms of spot price and futures contract over time.
By way of example, FIG. 2 is a graph illustrating a contango curve 200. There is an X axis 201 that represents time to maturity for a forwards contract. The Y axis 202 represents the cost or price of the forward contract. A contango environment occurs when a current price 203 of a futures contract is above the expected future spot price, since a current spot price 204 is below the price of the futures contract. A spot price is the current price a particular commodity can be bought or sold at a certain time and place. When this happens, there will be a negative roll yield, when the futures contract matures. A negative roll yield is a loss on an investment. This is partly because roll of front month contracts exposes investments only to the front-end of the curve (see FIG. 1, 101). A negative roll yield occurs from a roll of front month contracts when a futures contract is bought at a higher price 101b and sold at a lower price when the front month contract matures at a certain point in the future 101a. Then a futures contract is bought with the same tenor as that of the futures contract bought at 101b and therefore will take the same time to mature.
Backwardation is the opposite of contango. FIG. 3 is a graph 300 illustrating an example of a backwardation curve 304. There is an X axis 301 that represents time to maturity for a futures contract. The Y axis 302 represents the price of the futures contract. Backwardation occurs when the spot price 303 for a commodity is higher then the price of a futures contract 304 for the commodity. It is possible to take advantage of a backwardation by selling at the spot price 303 and buying the futures contract 304. This strategy is possible when an investor owns the actual physical commodities and does not have to use them immediately and, therefore, can deliver them at spot 303. However, an investor in a traditional commodity indices eventually may have to exit such a strategy since he may not be able to deliver the commodities at spot price 303 when futures contract 304 matures. The investor would be able to take advantage of backwardation if physical delivery of the commodity was not necessary.
Additional drawbacks of baskets of futures include a lack of transparency, absence of weight control, and absence of rebalancing. By lack of transparency, it is meant the inability, or difficulty, of monitoring the details of investments. Weight control is the ability to assign the proportion, weight, of a particular futures contract in a basket, commodity index. Rebalancing ensures that the weight of the futures contract in a commodity index remains the same, as the price of the futures contract fluctuates over time.
An attempt to solve the above problems has led to approaches that include the use of rule based indices. However, these approaches are increasingly complex and provide little flexibility or choice.
In view of the foregoing, there is a need for an improved solution for investing in commodities. In particular, there is a need for methods and systems for providing a constant maturity index, where the investor may escape the limitation of nearby only vehicles embodied by other major commodity indices and escape being locked into a potentially undesirable part of the curve. Nearby only vehicles refer to buying front month contracts with the same tenor and waiting until they mature before repeating the process. The solution should provide the investor with the ability to invest in an index that is diversified across a wide range of commodities, provides choices as to the tenor of their investment, has continuous roll and constant maturity features to mitigate negative roll yield in a contango environment and be able to take advantage of a backwardation environment, and more accurately reflects the real commodity markets. Continuous roll and constant maturity refers to continuously buying and selling futures contracts at different tenors, and not necessarily waiting till a front month (futures) contract matures. For example, a front month contract may be bought at point 102b that matures at point 101a. However, the proposed solution would allow to sell the front month contract at point 102a after a certain period of time 102. Finally, the index should be continuously rebalanced to target more consistent weights for the index's components, and the weights of the individual components should be maintained so that the index reflects changes in the market affecting the various components.